Transition looms for China in 2013

The commodities analyst for investment bank CLSA in Shanghai says iron ore won’t still be above $100 a tonne in 12 months.

“It’s a transition year [2013] and the last time you will see a three-digit iron ore price," Roper says.

While this gradual price decline is likely to cause further budget pain in Canberra, it also tells us much about where China sits on its development path. The world’s second-biggest economy has spent much of the past decade building roads, rail lines and residential apartment blocks.

This will continue in 2013 but the pace of activity has been deliberately slowed at a time when new sources of iron ore are coming on the market.

So while the next 12 months will be a “transition" period for iron ore, it will equally be one for China.

The country’s new leaders have indicated they will begin the long and delicate process of changing the drivers of growth.

To do this they must overcome their addiction to boosting growth by unveiling new building projects and undertake serious reform to develop an economy that is built around a strong service sector and consumer demand.

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This will take time but 2013 should be the start of this “transition". At its annual Central Economic Work Conference in December, China’s government said it would draw up a “comprehensive" reform plan. “This implies the leadership has yet to agree on how to proceed," the chief Asia economist for Capital Economist, Mark Williams, says.

But it also suggests the new leadership has agreed that major reform is necessary, given its statement on the need for “politically courageous" decisions.

In the meantime, expect the economy to continue ticking over with what the government has described as “proactive fiscal policy and prudent monetary policy".

On the monetary side, this suggests little change to official interest rates or the amount of capital banks are required to keep aside, known as the reserve requirement ratio.

The market is expecting one interest rate cut at the most in the next year and a similar stance on the RRR. “I feel there is no evident pressure for the central bank to take aggressive easing policy," says Jin Zhongxia, the head of a research institute under the People’s Bank of China, the central bank.

“I think we will not see a big inflation rebound in 2013."

Officially, the government is targeting an inflation rate of 3.5 per cent for the year but this is unlikely to be met given prices rose just 2.2 per cent in November from a year earlier. While inflation is likely to remain low, there are equally only modest expectations for a pickup in growth this year.

“We expect the Chinese economy to grow by 8 per cent in 2013, compared to 7.6 per cent in 2012," JPMorgan economist Zhu Haibin says in a note to clients.

Zhu says the slight rise in growth will come despite continued export weakness and be supported by a modest increase in fixed-asset investment.

“Given the very high public expectations . . . and increasing challenges in sustaining economic growth, we believe that economic reforms will continue under the new leadership," he says.

The jumping-off point for any such reform is likely to be March, when Xi Jinping officially takes over as China’s president and Li Keqiang becomes premier.

Li will have overall stewardship of the economy and his focus is expected to be on urbanisation.

He has commissioned the World Bank to undertake a landmark study on what China requires to complete its next stage of migrating more people to urban areas.

This is likely to involve a study of the healthcare, education and service requirements over the coming decades if China is to continue urbanising.

But, unlike the rapid urbanisation of previous decades, this new push by Li is not expected to be characterised by a building boom but rather by so-called “soft infrastructure".

But the report could also be used as the basis to allow greater private capital into sectors such as health and education and as a vehicle to bring about economic and social reform.

One of the main issues is China’s system of hukou, or residency permits, which often prevents people accessing state benefits outside the province where they were born. This hinders labour mobility and also means migrant workers cannot fully participate in the economy. They don’t receive subsidised healthcare, often find it hard to buy property and cannot enrol their children in school.

It is also an impediment to further urbanisation in China and contributes to lower levels of consumption. It is estimated that more than 100 million people are trapped in this limbo and means the real urbanisation rate is more like 40 per cent, not the figure of 50 per cent which is often quoted.

Beginning to reform this outdated system would begin the process of rebalancing the economy away from investment-led growth, towards consumption.

“Expanding domestic demand holds the key," HSBC economist Qu Hongbin says. “We see favourable conditions for Beijing policymakers to step up reforms because economic growth has bottomed out and recovery momentum is strengthening."

Qu expects Beijing to lay out concrete reform plans over the next few months, possibly after the official handover in March. He expects tax cuts, a greater focus on upgrading industrial infrastructure, more support for low-income earners, and tight controls to be maintained on the property sector.

“The new leaders have put more emphasis on the quality of growth and long-term sustainability," he says.